Contracts for Difference in European Electricity Markets: Evolution, Challenges, and Future Prospects

Contracts for Difference (“CfDs”) have become one of the central instruments used in European electricity markets to support renewable energy investment. By stabilising revenues over the long term, they reduce investors’ exposure to wholesale price volatility, improve project bankability, and can help governments accelerate the deployment of renewable technologies. At the same time, their design has important consequences for market efficiency, especially as electricity markets mature and the share of renewable generation increases. In particular, conventional CfDs can weaken producers’ exposure to price signals, create incentives to maximise output regardless of system value, distort intraday and balancing markets, and leave some forms of volume risk unhedged. This thesis analyses the evolution, design, and future role of CfDs in European electricity markets. Its guiding question is how CfD design should evolve in order to remain effective as renewable penetration grows and European power markets become more mature. The analysis first examines the economic rationale of CfDs and their growing adoption in Europe, especially in the transition from administratively set feed-in tariffs to auction-based support schemes. It then studies the conventional CfD design, focusing on its key parameters: reference price, reference volume, and strike price. The analysis shows that the same features that make conventional CfDs attractive as risk-mitigation instruments may also generate distortive incentives as renewable penetration increases. The thesis then evaluates a set of design innovations, including cap-and-floor mechanisms, negative-price safeguards, financial CfDs, and yardstick CfDs. While incremental safeguards can reduce specific distortions, more structural alternatives better preserve market signals but introduce higher implementation complexity and basis risk. Finally, the thesis compares CfDs with Power Purchase Agreements and discusses their complementary role in a maturing renewable energy market. The main conclusion is that CfDs are likely to remain relevant, but their future design should move beyond simple revenue stabilization and increasingly balance investor protection, consumer protection, and efficient market integration.